Below is my current SPX position.
The position is comprised of 2 trades: I bought a 5-lot of $75-wide Put Vertical Debit spreads to initiate the position and, after SPX dropped, I rolled down the long Puts by $25 creating a 5-lot $50 wide Put Vertical Debit spread and, in the same transaction, I sold a 10-lot of $25-wide Put Vertical Credit spreads. That transaction generated a Credit of $19.40 which offset 100% of the cost of the original Debit spread. That meant I owned the current option position for a net $0 cost!
Travis asked why I sold 10-$25 wide credit spreads instead of 5-$50 wide spreads. What a great question!
When I’m building an option structure I’m looking at both the current P/L slope (purple line on the risk profile) as well as the steepness of the P/L line at expiry (blue line). That expiry line represents not only the P/L but it also represents Gamma risk at expiry. My current Gamma risk is -.07 or essentially zero. That’s great for a low directional-risk position. But that’s today’s Gamma risk. Let’s imagine the position 1 week from today. Let’s say $SPX is at 4225 at the day’s open. If price remains there or trades as high as 4275 my profit on the trade will be $25,000 at the end of day. But, should SPX drop by 25 points from the open down to 4200 my profit on the trade will be…$0. š² A 25 point move will cost me $25,000! That’s due to the Gamma risk. Now imagine price opens next Friday at 4275 instead. If SPX rallies by 25 points my profit will drop from $25,000 to…$12,500. That’s a big drop in profits but it’s just half the drop in profits compared to the first scenario! To recap: the maximum $25,000 profit occurs if price is anywhere between 4225 and 4275 at expiry. If SPX is 25 points below that range at expiry my profit is $0 and if price is 25 points above that range at expiry my profit is $12,500. My Gamma risk if SPX is at 4225 on expiry day is much greater than if SPX is at 4275 on expiry day.
You should be able to tell from the structure of the trade that I’m expecting that it’s more likely that SPX price may be testing the 4275 price level than the 4225 level at next Friday’s close and so I want less Gamma risk in that area.
Questions and comment are always welcome!